SEC Settles Churning Case Involving Elderly Nuns

Just the other day, "Street Sweeper" published a story about elder abuse on Wall Street. Little did we know that the next day, the Securities and Exchange Commission (“SEC”) would announce the settlement of a case involving the financial abuse of two brokerage accounts operated for elderly nuns!

Background

Capital Growth was a registered broker-dealer with offices in Boca Raton, Florida and New York, New York, until February 2008, when it ceased operations due to its failure to meet net capital requirements.

Paul George Chironis, age 57, worked in the securities industry since 1981 and maintained Series 7 and 63 licenses since 1983.

Prior to his association with Capital Growth, seven customer complaints were filed against Chironis with the NASD/FINRA, including complaints for churning and unsuitability. In January 2006, the Michigan Securities Division required that Chironis be placed on heightened supervision; and in March 2006, the Vermont Securities Division prohibited Chironis from soliciting investors in Vermont.

Chironis was associated with Capital Growth from November 2005 until February 2008, when Capital Growth ceased business operations. Records maintained by the Financial Industry Regulatory Authority indicate that Chironis was registered with Dawson James Securities, Inc. from February 2008 until March 2009; and thereafter with HFP Capital Markets, Inc. since March 2009 where he was still indicated as employed as of a review of FINRA's records on January 7, 2011.

The Sisters of Charity is a congregation of mostly elderly nuns residing in Bronx, New York. During the relevant period, the Sisters of Charity maintained two accounts (collectively "the Accounts") at Capital Growth:

General Fund Account (“General Account”) used for operational purposes, including paying for the care of members of the congregation living in assisted living facilities, and

Charitable Trust Account (“Charitable Account”), used for the Sisters of Charity’s charitable endeavors.

The Accounts’ primary purpose was income generation, and the Sisters of Charity had a low risk tolerance. Both accounts held primarily conservative, income producing assets that were predominantly mortgage-backed securities, including securities issued or guaranteed by the Federal Home Loan Mortgage Corporation (Freddie Mac), the Federal National Mortgage Association (Fannie Mae), and the Government National Mortgage Association (Ginnie Mae) (collectively, “MBS”). The Accounts also held some closed-end bond funds and a small amount of corporate bonds. During the relevant period, the combined balance of the Accounts totaled approximately $8 million. Chironis was the registered representative on both Accounts.

The Heave-Ho from Merill Lynch

In October 2003, Sisters of Charity transferred the Charitable Account to Advest, Inc. (“Advest”), where Chironis worked as a registered representative and he was assigned to handle the Accounts. Merrill Lynch & Co. (“Merrill Lynch”) acquired Advest in November 2005, and Merrill Lynch subsequently rescinded Chironis’ offer of employment, in part, because of prior customer complaints against him (see above), including complaints of excessive trading.

Capital Growth

At Advest, Chironis earned 42% of markups and markdowns. Chironis relocated to Capital Growth, where he was given 60% of the amount of the markups and markdowns paid by his customers.

In December 2005, the Sisters of Charity moved the Charitable Account from Merrill Lynch to Capital Growth, and in July 2006, the Sisters of Charity opened a second account, the General Account, at Capital Growth. Chironis continued to be the broker of record for both accounts.

The SEC alleges that during the 13-month period from January 2007 through January 31, 2008 (the “Relevant Period”), Chironis engaged in an abusive trading pattern that featured excessive trading and charging excessive markups and markdowns on riskless principal bond trades.

46 Bond Purchases

During the Relevant Period, the Accounts were charged an average markup of 3.68% on 46 bond purchases, and 3.03% on 33 closed-end fund purchases. Of the 46 bonds purchased, Chironis sold 38 within the same period. The average holding period for bonds acquired and sold during the Relevant Period was only 4.3 months.

Bond and Bond-Fund Charges

During the Relevant Period, Capital Growth charged an average markdown of approximately 1.92% on 67 bond sales; and average markdown of approximately 1.86 % on 15 closed-end bond fund sales. During the Relevant Period, the gross charges totaled $959,027, which was approximately 10.8% of the combined average value of the Accounts. Embedded in those charges were an amount earmarked for Chironis (the bulk) and an additional charge by Capital Growth's trading desk.

Churning

During the Relevant Period, Chironis purchased 46 bonds for the Accounts – 39 MBS and seven corporate bonds – worth approximately $12.2 million; and sold 38 of the bonds – worth approximately $9.6 million – within the same period. The average holding period for the 38 securities bought and sold during the Relevant Period was 4.3 months.

Chironis frequently replaced one bond with a bond or bonds of similar duration and yield. The SEC asserted that such in-and-out trading was little more than a substitution of similar securities, which raised the inference that the trading was not calculated to be in the customer's best interest but may well have been churning.

For example, on July 24, 2007, Chironis sold a Ginnie Mae bond with a 6% coupon rate, a maturity date of 2033, and a principal amount of $258,504.43.

On July 25th, Chironis purchased another 2003 6% Ginnie Mae with a principal amount of $201,636.05, along with a second 2032 6% Ginnie Mae with a principal amount of $199,956.51.

Those three transactions incurred about $18,352 in markups and markdowns. Thereafeter, on September 26, 2007 and on October 24, 2007, Chironis sold the two Ginnie Maes.

Churning refers to the excessive buying and selling of securities in your account by your broker, for the purpose of generating commissions and without regard to your investment objectives. For churning to occur, your broker must exercise control over the investment decisions in your account, either through a formal written discretionary agreement or otherwise. For example, if you relied on your broker's advice because you were unable to evaluate the broker's recommendations and exercise your own judgment, your broker may have exercised control over your account.

Also, Chironis purchased 33 closed-end bond funds , worth about $6.5 million, and then sold 12 of those funds worth about $4.3 million during the same period. The 12 sold funds had been held for an average period of 4.8 months.

For securities that Chironis bought and sold within the Relevant Period, the Accounts experienced a realized loss of approximately $639,000. The combined unrealized and realized loss for the Accounts as of December 31, 2007 was $1,170,000, most of which is attributable to transaction fees.

When recommending transactions to the Sisters of Charity’s Chief Financial Officer, Chironis did not disclose the transaction costs or their impact; nor did he identify the short-term holding status of the fixed income securities he recommended selling. The SEC deemed that in light of the transaction costs, the transactions were not in the best interest of the Sisters of Charity

Markup/Markdowns

Capital Growth charged the Accounts on a per-transaction basis by marking down bond sales and marking up bond purchases in “riskless principal” transactions.

Riskless Principal: is the economic equivalent of an agency trade. A broker-dealer engaging in such trades has no market making function, buys only to fill orders already in hand, and immediately “books” the shares it buys to its customers. Essentially, the firm serves as an intermediary for others who have assumed the market risk. In other words, the customer purchaser is already lined up before the broker-dealer buys the bond. On such transactions, if a customer wishes to purchase a bond, a broker-dealer locates the bond, purchases it on the open market, and then resells it to its customer at a markup. The reverse is true when a customer sells a bond.

Account statements sent to the Sisters of Charity disclosed the markups and markdowns charged on closed-end bond fund but not the charges for bond purchases and sales. Consequently, the Sisters of Charity were unaware that they were paying approximately 10.8% of the value of the Accounts in transaction fees over 13 months.

In addition to the markups charged by Chironis, which generally ranged from 2.75-3.0%, the Capital Growth trading desk would typically add a percentage markup or markdown of between 0.25-0.75% to compensate the trading desk. Chironis and the trading desk followed a similar procedure for markdowns on bond sales, though the markdowns were generally lower than the markups. In determining that the charges were excessive, the SEC gave considerable weight to the facts that:

Neither Chironis nor the trading desk did significant work in purchasing or selling bonds and MBS for the Accounts.

The market for these securities that Chironis purchased and sold for the Accounts was highly liquid.

Chironis did little or no research for the transactions. He simply instructed the trading desk as to the type of security he was looking to purchase or which security he wanted to sell.

Although the trading desk did some work, including locating bids and offers and negotiating with counterparties, because the market was highly liquid, the work performed by the trading desk was minimal.

The SEC's found that Chironis violated Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. Chironis agreed to a Bar from association with any broker, dealer, investment adviser, municipal securities dealer, transfer agent, municipal advisor, or nationally recognized statistical ratings organization. The SEC's Order also prohibits Chironis from serving or acting as an employee, officer, director, member of an advisory board, investment adviser or depositor of, or principal underwriter for, a registered investment company or affiliated person of such investment adviser, depositor, or principal underwriter.

Additionally, Chironis agreed to pay a $100,000 penalty and $250,000 in disgorgement that will be placed in a Fair Fund and distributed to the Sisters of Charity.